This Too Shall Pass

This Too Shall Pass
Economist Christopher Thornberg, who foresaw the single-family housing meltdown, advises developers to take a deep breath and ignore trends.

By Jerry Ascierto
APARTMENT FINANCE TODAY, 2009-03-12

As an economist with UCLA's Anderson Forecast, Christopher Thornberg has garnered a reputation as something of a pessimist. In late 2003, Thornberg began warning about the single-family housing bubble and the risks facing the broader economy. He was often met with unbelieving, blank stares by the real estate industry professionals who came to hear him speak.

Thornberg's forecast has certainly proven prescient. But he believes that the doom-and-gloom scenarios currently dominating economic discourse are far too pessimistic, that irrational greed has now given way to irrational fear.

Thornberg, who in 2006 founded the Los Angeles-based research and consulting firm Beacon Economics, recently sat down with Apartment Finance Today to offer his view of what went wrong, and when the economy will start to right itself.

AFT: So, have you developed a Cassandra complex? Do you feel doomed to see the future but powerless to change it?

CT: I'd call it job security. When you sit down and think about the mistakes that were made—forgetting risk, forgetting about fundamentals—how many times has this been done in the past? The magnitude and scope of this one is pretty awe-inspiring, but it's the same stupidity and the same greed, the same mistakes.

I have a much better sense of the whole Keynesian greed and fear model now. Because when you boil it down, you can talk yourself blue in the face, but those two emotions dominate people's rational thinking. There was no way that anyone could have justified those kinds of crazy cap rates and lending rates and terms. It just didn't make any sense. But it was shocking to me how people refused to acknowledge the obvious.

AFT: Did you anticipate that the single-family housing meltdown would have the kind of ramifications it's had throughout the economy?

CT: Yes, but it's not single family. Single family was the symptom not the disease. The real problem was consumer spending. We had asset prices across the board at local levels that weren't realistic, given GDP. Now, they're crashing down, and, as a result, Americans who thought they were rich and were overspending are no longer taking the risk or overspending. That was the problem in the economy. Single family was just the most outrageous aspect of the entire disaster. When everything started tumbling down, it was the first to go. But housing is not a driver, it's the canary in the coalmine.

AFT: The talking heads out there are increasingly saying that this will be a five-year downturn, or even that we're entering a depression. Has the current discourse become too pessimistic?

CT: Absolutely. At some point in time we moved through the structural collapse. The housing prices in California, for example, have gotten back to historic normal levels relative to incomes in the state, yet they're still falling. Stock prices and P/E ratios for a lot of companies have reached levels that make them terrific deals if the stock market continues to fall. When you look at the firms and the money they're making, it's pretty clear the stock market has fallen too far.

AFT: So, where's the bottom? Does the economy have to get worse before it gets better?

CT: The big driver of the economy at this point is by far the consumer and the fact that consumers had been overspending. Savings rates had gone from 8 or 9 percent down to 0 percent and that just wasn't sustainable. Everybody talks about how we need to expand credit, that the consumer needs more credit so they can go spend more. Every time I hear a politician say that I want to scream. The problem in the economy is too much credit that boosted consumer spending. It's like this man is dying of alcohol poisoning, quick give him a beer!

You're not supposed to use credit to consume. Credit is for investment, credit is for the future. You buy a car on credit because the car will give you value over the next five years; you buy a house on credit because that will give you value over the next 20 years. You don't buy an iPod on credit, and you don't buy food on credit. You buy that from your income.

So the good news is that savings rates have gone from basically 0 percent to 5 percent in the last five months. What this means is that in a few months, at the pace we're going, we're going to have an 8 percent savings rate. That's when we'll see consumer spending stabilize. Now there's the injury, and then there's the healing. So when consumer savings hits 8 percent or 9 percent the injury is over, but we're still going to have a year of healing.

AFT: Outside of consumer spending and savings rates, what other leading indicators will point to the early signs of a recovery?

CT: You'll know that this is over when you see industrial production stabilize, when you see retail sales stabilize, when unemployment stops rising. The end of a recession is dictated largely by unemployment stopping its increase.

AFT: Do you see these indicators, the early signs of a recovery, coming to light anytime soon?

CT: Not yet, we're still in the thick of it. However, the signs that we're reaching the bottom are clearly there. Prices for homes have gotten into a realm that is starting to make sense. You are starting to see the beginning of an increase in sales. You're starting to see the basic signs that assets are getting back to a level that makes sense. When you add this all up, we're moving through this.

And everybody keeps freaking out, thinking that whatever happens today is going to happen tomorrow, but it's that same mentality that got us into this mess in the first place. It's the easiest way of thinking about the economy, and I mean that with disdain. The standard view of the world is that the trend is your friend. And it's exactly that kind of thinking that's the problem. People should be thinking about fundamentals.

AFT: What do you think of the Obama administration's response to this crisis?

CT: Under the circumstances, I think it's been very good. There have been parts of some programs I don't like. I don't care for their homeowner bailout bill. I think their fiscal spending is weighted too heavily at the back end. However, you have to remember that the Obama administration has an important restriction upon their ability to do anything-they're the executive branch. They're supposed to enforce laws, they don't make laws; they're supposed to enforce programs, they don't design programs. Considering that he has 532 knuckleheads between him and results, I think he's doing a hell of a good job.

AFT: When will we see GDP growth again?

CT: You're going to see GDP start to grow again first and second quarter of 2010.

AFT: Any words of advice for single-family and multifamily developers?

CT: Take a deep breath and just recognize that this too shall pass. Think about fundamentals and stop thinking about trends. Trends are not your friend; your friend is fundamentals. When you sit down and remember that, you'll see that things aren't that bad, and we will get through this.